Columnist Shishir Khadka, founder and CEO of Boost Accounting, is an author, international speaker, and financial transformational coach. Shishir helps entrepreneurs build financial confidence and successful financial stories, transforming client businesses from £150k to £38.5m.
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Regular readers of Smart Technology Guide will have read and got to grips with Phase 1 of Making Tax Digital. A scheme by HMRC, MTD is supposed to make filing taxes for small businesses less complicated. As a result, the government aims to claw back a significant chunk of the £9 billion it loses each year due to tax complications.
Introduced in April 2019, the first phase was a “soft landing” for businesses so that entrepreneurs and owners could get used to the alterations. In 2020, HMRC plans on rolling out the second part of the Making Tax Digital framework.
So, what does that mean for you and your business? Will you benefit from the changes? Will filing a corporate tax return finally be a walk in the park? To find out more about Phase 2 of MTD, and how it will affect your company, please continue reading.
The Current Legacy Of Making Tax Digital
Before you learn more about Phase 2, it’s essential to understand the background of Phase 1. Although it was created to transform the process, it hasn’t been as well-received as the government would like to admit. By June 2019, an estimated 10% of SMBs had signed up to the system, meaning a massive 90% of companies are non-compliant. Not only that, but loopholes still exist and bridging software can bypass rules set out by MTD.
Therefore, Phase 2 aims to make it much harder to avoid Making Tax Digital regulations so that 100% of businesses are compliant.
Making Tax Digital: Phase 2
Phase 2 is by no means easy to understand, and there are lots to consider for SMBs. Here is a selection of the issues companies will need to address:
- Specific rules on uploading tax returns
- These centre on the software and links used by businesses
- Incurring penalties due to non-compliance
Typically, SMBs that use Excel and other basic accounting software wasn’t overly impacted by the changes in Phase 1. The reason for this was that bridging software allowed companies to continue to use these methods without any hiccups. However, Phase 2 means that digital links will only upload permanent data. Therefore, only accredited apps will be accepted as other platforms are not powerful enough for the task.
While Phase 1 focused on VAT, and it will be an integral part of Phase 2 also, income tax will be included in the Making Tax Digital umbrella, too.
Who Is Affected By Making Tax Digital?
Firstly, it’s small business owners who haven’t already invested in accounting software. Any organisation that uses Excel, or another application that isn’t accredited, won’t be able to upload a tax return digitally. In the first phase of Making Tax Digital, this only applied to VAT-registered businesses with a taxable turnover of £85,000 or more. Step 2 plans on expanding the scope to all companies, regardless of profits and turnover.
Due to the introduction of MTD regulations for income tax, businesses are not alone. Anybody who is considered self-employed will also be liable to submit a self-assessment tax return digitally. Those who have to sign-up must:
- Be a sole trader with income from one business only
- Rent out UK property
You can’t sign-up as a self-employed MTD member if:
- You receive income from elsewhere
- You have to report other taxable payments
- Claim tax relief on separate payments
Since Phase 1, one group that is no longer exempt is charities. Like every business with £85,000 of turnover, they must comply with mandatory MTD rules.
What Are The Options For People Who Must Be Compliant?
At the moment, the options are still hazy. While it intends to implement MTD across the board in the future, HMRC has declared that it won’t mandate new taxes or businesses in 2020. This is to help VAT-registered companies transition to the rules.
As a result, SMEs don’t need to comply with Making Tax Digital this year. Self-employed people are also exempt from Phase 2 for 2020. Of course, this is only a period of transition, and MTD will be introduced across the board in 2021 and beyond.
So, it’s smarter for companies who are yet obliged to comply with MTD rules to make changes now. That way, it won’t be a massive shock when the alterations are finally finalised.
How To Comply With HMRC’s Rules
Aside from investing in holistic accounting software, the key is to digitise the relevant records. Permanent data is the first, and best place, to start as it’s mandatory. This information includes, but isn’t limited to:
- The business’ name
- Business address
- VAT number
The VAT account number and any transactional data is essential, too. As well as allowing you to submit the information digitally, the info also acts as evidence for the original data links. That is the digital records part of Phase 2, but there is also a sales and purchase aspect. For any sale and purchase, Phase 2 means you must make a record of the tax point and its value. The amount of VAT that was charged is another factor to write down and maintain for safekeeping. Lastly, the amount of input tax needs to be recorded.
A Note About Compliance
Something that businesses and individuals might not spot is that the information above is required for each supply. How might this impact you in the future? It means that recording invoice totals might not be sufficient concerning digitising your data. This is because specific invoices could have more than one supply, and that would make your non-compliant with MTD.
Making Tax Digital: The Consequences Of Non-Compliance
When the legislation is applied across the board, the penalties for non-compliance are slated to be severe. This is so that HMRC can make a point of any business or self-employed individual that isn’t signed up to the platform. And, although there is an amnesty on new taxes and rules for companies, the suspension of penalties is due to end.
What happens when it does? How much would it cost you or your company? The answer depends on the number of offences. The worst offenders will be subject to fines that accumulate to 15% of the tax owed within a calendar year. Smaller percentages are feasible, too. It will come down to how often you’ve offended over twelve months.
Another significant penalty is for the organisations and people who are suspected of making deliberate errors. For these, the threshold of a fine is 100% of any VAT that is undeclared due to fraudulent activity. Also, careless mistakes are subject to the same penalty, which is why businesses must work hard to comply with the rules from the outset.
The Benefits of Being MTD Complaint
Whether you are a fan of Making Tax Digital or you see it as an unnecessary evil, there are undoubtedly benefits. Systemising your company’s records gives you the ability to save money, first and foremost. After all, your data will be more organised, making it accessible and easy to reach for everyone in the organisation. This is by no means a theory, either. SMBs generated an estimated £815 million in 2019, thanks to Making Tax Digital. Owners put this down to having a better view of their finances, allowing them to make more informed monetary decisions.
Time is another resource that businesses value above most. From a Making Tax Digital perspective, it’s easier than ever to save because financial records are digitised. With more time, you can expect to increase productivity and output by investing it back into the most vulnerable areas of the firm. More than 50% of compliant MTD businesses agree, too. They believe an increased rollout would save them even more time and increase productivity further.
The Future Of Making Tax Digital
It’s safe to say that confidence in Making Tax Digital isn’t high. A huge 55% of small businesses and individuals assume that their understanding is lacking. As a result, they are fearful of penalties and fines that could set their company back significantly. Does that mean MTD is bad?
No. If anything, the thinking is the opposite. While there is trepidation among the wider public, the experts believe that digitising is the key for businesses that want to expand. Companies are set to benefit from a better understanding of their finances because it enables them to:
- Spot anomalies
- Share data more efficiently
- Improve invoicing processes to prevent wastage
- Comply with the law
Ensuring that MTD rules are enforced is going to be HMRC’s pet project in the coming months and years. Still, it doesn’t mean businesses and individuals won’t benefit. By getting on board, you can seize an opportunity to grow. After all, you’ll have a broader view of integral company processes, and you’ll eliminate common, costly mistakes.
Making Tax Digital is a priority for small businesses, regardless of the start date. Hopefully, these two articles make it more straightforward to comply and take advantage of the new regulations.
For more information on Phase 1, please check out our post by following this link.